LLP members to be allocated losses (subject to the point on projected profits mentioned earlier).
Cost plus arrangements Worryingly, HMRC have suggested that UK LLPs that operate on a ‘cost plus’ basis may not be capable of meeting the ‘disguised salary’ test. They have included as an Annex examples of ‘global structures’ and the issues these businesses may face with the ‘salaried members’ tests. Para 1.4 of the Annex deals with a ‘cost plus’ basis of profit allocation.
1.4 Cost plus basis If the profits of the UK LLP are calculated on a cost plus basis, then Condition A is satisfied (i.e., the LLP member will be treated as a ‘salaried member’ as the level of profits vary with the rewards to the members rather than the members receive a reward that varies with the profits of the LLP).
EXAMPLE 9 This is illustrated in the following example.
P and Q are members of P&Q LLP which is a fund manager associated with a US firm. All fund management fees are paid directly to the US firm.
P and Q provide services to the US firm and agree at the end of the year that based on the profits of the US firm, £300,000 will be allocated to P&Q LLP as their remuneration, in addition to an amount equal to the costs of the business of £500,000. The LLP has agreed a ‘costs plus’ basis with HMRC and therefore the profit taxable in the UK will also include an additional £80,000 (i.e., a 10% mark-up on costs including the members’ remuneration).
The £300,000 is not in practice variable by reference to the overall amount of the profits of the UK firm because it is set according to the profitability of the associated firm. Therefore it is disguised salary. Similarly, the additional £80,000 varies according to the members’ remuneration and other costs, not the profits of P&Q LLP. P and Q meet Condition A.
This seems both concerning and also logically incorrect. P and Q do not provide services to the US firm. Rather P&Q LLP provide those services. The reward for those services in the above example is £880,000 and has been agreed as a proper calculation of the split of profits of the combined businesses. The split of the £380,000 profit would seem to be relating to the profits of the UK LLP’s business. However, LLPs in this position would be wise to ensure that the members are exempted from being ‘salaried members’ by one of the other criteria.
There are other examples in the guidance with profit-sharing in global businesses that are also not
helpful. HMRC are taking a hard line where an LLP member may take a relatively small fixed sum from a UK LLP, but where they do truly share in the profits of a worldwide LLP. In this situation, HMRC suggest that in respect of the UK LLP, the member will be a ‘salaried member’.
Condition B – Significant influence There has been little change in the updated consultation for most businesses as regards the definition of ‘significant influence’. Those members that are involved with the strategy and key decisions of the LLP as a whole will have ‘significant influence’ and not be ‘salaried members’. This is not a reflection of voting rights necessarily, or indeed professional qualifications, but rather the role the member plays in the running of the LLP. HMRC equate this to be broadly a member of an executive or management committee.
In a small partnership, this may be the easiest and cost-effective way of ensuring that LLP members are not caught by the ‘salaried member’ rules. Meetings should be held regularly, at least quarterly, and minuted.
Regulated businesses One important change is that HMRC now accept that for businesses that are regulated by the FCA, the definition of ‘significant influence’ includes those with investment authorisations.
The section is worth including in full:
2.5.3. Significant influence functions of financial businesses regulated by Financial Conduct Authority (FCA)
The Financial Services and Markets Act 2000 says that a significant influence function, in relation to the carrying on of a regulated activity by a firm, means a function that is likely to enable the person responsible for its performance to exercise a significant influence on the conduct of the firm’s affairs, so far as it relates to the regulated activity.
A person carrying out such a function in relation to an authorised firm must be an FCA-approved person.
The context of the FCA significant influence function test is different from that of the significant influence rule in the salaried member legislation. However, HMRC would accept that the following FCA “significant influence functions” are likely to result in the individual exercising them having significant influence for the purposes of Condition C: CF3 (chief executive function) and CF8 (apportionment and oversight function). On the other hand, CF4 (partner function) merely
means that the individual has to be FCA-approved by virtue of being a member of the LLP (and as a result of which the FCA presumes the individual to have influence). Whether this in practice results in the individual having significant influence over the affairs of the LLP as a whole is a question of fact. In cases where the firm’s activities consist wholly or almost wholly of regulated activities and the individual in question significantly contributes to the firm’s major decisions (management, strategic or investment-related), then it is likely that HMRC would accept that this constitutes significant influence for the purpose of Condition C.
EXAMPLE 32 This example looks at an example of whether someone who fulfils a function required by a regulatory body can satisfy Condition B.
X is a member of XYZ LLP, a regulated asset manager. X is a key portfolio manager, but not on the managing committee of XYZ LLP.
X is authorised by the FCA and holds Controlled Function CF4 for FCA purposes, which is listed as a ‘significant influence’ function. In addition, X makes significant investment decisions in relation to one of the funds under management.
X fails Condition B because of his significant influence over the LLP.
Capital contributions to the LLP Where an LLP member contributes as a capital contribution at least 25% of the amount that would be considered to be disguised remuneration, then they will not be considered to be a ‘salaried member’. Capital contribution includes all amounts invested as capital (including long-term loans) but not a current account or short-term loans. One change in the updated consultation is that an LLP member has three months to organise the capital, although they will be required to give an unconditional commitment to make the contribution. This will need to be given by 6 April 2014 for existing LLP members.
HMRC take the view that it is only capital in the UK LLP that can be considered for these purposes. Capital invested worldwide will not count. Businesses in this situation may need to move capital around to ensure that partners are not caught. This may not be easy (or even possible) in the timescale.
The analysis above is at a very high level. Every LLP will have different structures and processes, and what may be relevant and appropriate for one, may not be for another. Therefore, no LLP should act, or refrain from acting without seeking specific advice on their situation. THFJ
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